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The Case against a Tennessee Income Tax
by Stephen Moore and Richard Vedder
Stephen Moore is director of fiscal policy studies at the Cato Institute. Richard Vedder is distinguished professor of economics at Ohio University.
No. 53
On November 2 the Tennessee legislaturewill convene a special session to debate reformof the state tax system. The center of the contro-versy is whether Tennessee should adopt a per-sonal income tax, as proposed by Gov. DonSundquist, to close an estimated $400 millionbudget shortfall.This study finds that a personal income taxin Tennessee would likely have two negativeeconomic effects. First, an income tax wouldalmost certainly reduce economic growth and job creation in the state. The absence of anincome tax in Tennessee gives Tennessee alarge competitive advantage over other stateswith which it competes for jobs and business-es. We find, for example, that Kentucky, a statevery similar to Tennessee except that it has anincome tax, has had considerably weaker eco-nomic performance since 1980. Between 1980and 1998 the per capita economic growth rateof Tennessee was 47 percent compared to 36percent in Kentucky.The second negative effect of a state incometax would be to trigger much faster growth instate expenditures. That has been the almostuniversal pattern in other states after theyenacted a state income tax. Yet the premise of pro–income tax forces in Tennessee that thestate’s revenues have been growing too slowlyis contradicted by the evidence. In the 1990s,even without an income tax, Tennessee’s percapita tax receipts have grown 12th fastestamong the 50 states. Tennessee’s tax revenueshave climbed at twice the rate of inflation pluspopulation growth. The legislature should becutting taxes, not introducing new ones.
November 1, 1999
 
Introduction
Tennessee is currently one of nine remain-ing states without a personal income tax.
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That status may change later this year.Tennessee’s Republican governor DonSundquist has called for a special session of the state legislature to consider tax reformalternatives. One objective of this special ses-sion is to close a state budget shortfall esti-mated at between $300 million and $500 mil-lion. The longer-term objective is to totallyrestructure the tax system in order to perma-nently raise more tax revenues. Sundquist hasproposed a 3.75 percent personal income tax.This proposal is also supported by many busi-ness groups, the teachers union, and severalleading academics in the state.
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It is noteworthy that in running for reelec-tion in 1998 Sundquist never even broachedthe subject of an income tax with Tennesseevoters. In 1994 when he first ran for gover-nor, he pledged “never” to support an incometax.
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There is also serious debate as towhether a state income tax would violate theTennessee Constitution. In 1932 in
 Evans v. McCabe,
the Tennessee Supreme Court heldthat an income tax was unconstitutional,though a 1981 Attorney General Opinionsuggests otherwise.
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Leading the chargeagainst the income tax have been theTennessee Family Institute and a number of state taxpayer organizations.
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A recent pollsuggests that by about a three-to-one margin,Tennessee residents are opposed to anincome tax.
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Supporters of a personal income tax makethree arguments in favor of this new tax.First, they argue that the Tennessee tax sys-tem is regressive, with a heavier share of thetax burden borne by low-income residentsthan in most other states. Second, they arguethat the tax system is inelastic, meaning thattax receipts do not rise as fast as the stateeconomy. Finally, they maintain that toimprove the quality of education inTennessee more spending and tax revenueswill be necessary.This study assesses the wisdom of a stateincome tax. The first section examines therecent budget and tax trends in Tennessee.We refute the underlying premise of “taxreform” advocates by showing thatTennessee’s structural deficit problems are aresult of a huge growth in state expenditures,not insufficient revenues. Next the studyexplores the potential fiscal and economicimpact of introducing an income tax in thestate. We show that the likely effect for thestate would be higher state spending andlower economic growth. We conclude fromthis evidence that of all the options availableto close the state budget deficit, introducingan income tax in Tennessee would likely bethe single most economically harmful one.Tennessee derives large economic benefitsfrom not having an income tax, and it shouldnot forfeit those benefits.Finally, we make a series of positive rec-ommendations about how Tennessee couldimprove its fiscal climate. These recommen-dations include (1) tax and expenditure lim-its prohibiting the state budget from grow-ing faster than personal income; (2) voterapproval of any tax increase approved by thelegislature; (3) a two-thirds supermajorityrequirement to raise taxes or debt; (4) reformof the TennCare program, which is the majorsource of the budget deficit; and (5) a half-cent reduction in the state sales tax rate.
How Tennessee’s BudgetCompares
The Tennessee budget shortfall has beencaused exclusively by excessive spending, notinsufficient revenue gains. To understandwhy this is the case, it is helpful to review theoverall fiscal trends in the states and comparethem with those in Tennessee.Today, almost without exception, stategovernments are awash in tax revenues.Between 1992 and 1999 state revenues grewby more than 50 percent.
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If over the period1992 to 1998 states had restrained theirspending and tax collections to inflation and
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Tennessee deriveslarge economicbenefits from nothaving an incometax, and it shouldnot forfeit thosebenefits.
 
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population growth, the state tax burdenwould be $75.2 billion lower today, or $278less per person.
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The inflation-adjusted figures show thatthe states now spend roughly $600 more perperson than they did in 1990. Over the pastfour years, two out of every three dollars of revenue surpluses have been spent on newand expanded government programs. Onlyabout one-third of the surpluses has beenreturned to taxpayers.
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How does Tennessee fit into this generalnational picture of fiscal expansion? On theone hand, Tennessee remains a low-tax andlow-spending state. Tennessee ranks in thebottom 10 among the 50 states in almost allcategories of overall tax burden and spendingburden. Taxes and spending are about $1,000and $650, respectively, per person below thenational average.
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This status as a low-taxstate confers large comparative economicadvantage to businesses and residents in thestate. Over the past 10 years, Tennessee hasranked in the top 10 in almost all measuresof economic health, such as new-businessstart-ups in the 1990s. The Small BusinessSurvival Committee ranks Tennessee as hav-ing the ninth-best climate for business. Itnotes that Tennessee’s low tax burden is oneof the state’s most important business-friendly policies. The after-tax rate of returnon capital and investment in Tennessee isone of the highest in the nation.
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However, there are indications thatTennessee’s comparative advantage on fiscalpolicy is slowly eroding. The trend data indi-cate that in recent years state lawmakers inNashville have relied on huge surges in taxreceipts to build up the budget at a rapid pace.Since 1990, Tennessee has substantiallyoutspent other states, and its tax burden hasrisen more rapidly than all but a handful of states (see Tables 1 and 2).With respect to expenditures, Tennesseeranks 11th in overall growth of spendingfrom 1990 to 1997. The national average for
Table 1Total State Expenditure (millions of 1997 dollars), 1990
–
97
Increase,State 1990–97 Rank 1997 Rank 1990 Rank 
U.S. Total27.2%---$893,827---$702,591---
Oregon 58.8% 1 $12,388 27 $7,803 29Texas 52.9% 2 $48,887 3 $31,974 3Mississippi 51.5% 3 $9,006 31 $5,943 31Arkansas 48.1% 4 $7,685 32 $5,188 34Georgia 46.5% 5 $21,975 13 $15,004 14Idaho 46.1% 6 $3,674 43 $2,515 44Utah 43.9% 7 $6,818 36 $4,738 37Nevada 42.6% 8 $5,130 39 $3,598 41Florida 40.4% 9 $37,464 5 $26,687 8Missouri 39.1% 10 $14,230 21 $10,229 22
Tennessee38.4%11$14,28420$10,32321
West Virginia 38.1% 12 $7,145 34 $5,174 35North Carolina 37.9% 13 $22,864 11 $16,576 12New Mexico 37.7% 14 $7,059 35 $5,125 36New Hampshire 37.2% 15 $3,324 45 $2,423 46
Sources: Bureau of the Census; and authors’ calculations.
The Tennesseebudget shortfallhas been causedexclusively byexcessive spend-ing, not insuffi-cient revenuegains.
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TennesseeTerrorMan

Cato admits that TennCare has had 'rampaging costs' yet Cato is totally against a national healthcare system. Is that not IRONIC?

reply05 / 04 / 2012
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